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Writer's picture: Robert KnauerRobert Knauer

By Lindsey Rust


What role do skill and luck play in our failures or successes? Skill, defined as the ability to apply knowledge readily in execution or performance, can be improved through diligent practice, increasing chances of a desired outcome. On the other hand, luck is unpredictable and brought by chance. As described by Michael Mauboussin in what he calls the "paradox of skill," when the outcome of an activity combines skill and luck, as skill improves, luck becomes more important in shaping results.


All outcomes in our lives can be placed on a spectrum from pure luck to pure skill. Thinking of results as the sum of a draw from a distribution of skill and a draw from a distribution of luck, statistical theorem can be used to show that:


Variance(skill) + Variance(luck) = Variance(result)


In many areas, absolute skill has been improving, but the variance of skill has been shrinking. As an example, take the sport of marathon running. Compared to 1932, marathon runners today have access to better nutrition advice, scientifically-based training plans, and coaching, which has resulted in faster average times. This improvement in skill can be seen in Olympic gold medal times, as the gold medal men's marathon time in the 2012 Olympics was 23.5 minutes faster than the gold medal time from 1932. However, the difference between the 1st and 20th place times was 39 minutes in 1932 and only 7 minutes in 2012. As the variance in skill decreases and the variance in luck remains stable, luck is playing a growing role in determining winners and losers.


The same can be seen in the world of investing. As the absolute skill level of most investors grows over time, the relative difference in their skillset becomes narrower. As investors with similar skills compete against each other, luck often triumphs.


See also:


UPDATE 2 (January 12, 2021): With Democratic control of the Senate, the incoming Biden Administration will have an easier path to implementing its tax plan. The sense is that tax reforms — including an increase in capital gains tax for high income earners — stand a reasonable chance of being passed but a far lower chance of having an impact on taxes in 2021. More here, here, and here (with a paywall on the last link).


UPDATE (November 11, 2020): With the presidential election now behind us, focus shifts to control of the Senate. The outcome of the run-off elections in Georgia will determine whether the Biden administration will be able to enact its tax plan.


The political betting markets suggest that former vice president Biden will be elected in November. Though this is far from certain, it is useful to reflect on the implications of the tax policy changes of a potential Biden administration on the sale of a small business.


According to an overview of the proposed changes by the American Enterprise Institute, a Washington think tank, his plan would tax capital gains and dividends as ordinary income for taxpayers who report $1 million or more. This means that capital gains for high income earners will bump up to 39.6%, the highest tax bracket under the proposal. Currently, capital gains are taxed at up to 20%, so this increase would roughly double the current rate.


Whether these changes are enacted also depends on which party controls the Senate, which is currently up for grabs. Should the changes be adopted, they could be effective for the 2021 tax year.


So let's say you're selling your business for $10 million and are expecting $9 million at close with the remainder going into a seller note. Assuming $8 million in capital gains from the sale and no state capital gains tax, you'd take home $6.4 million under the current tax code and around $4.8 million under the proposed plan.


Worth thinking about if you are considering the sale of your business.

UPDATE (January 1, 2021): The Small Business Pulse Surveys, which the U.S. Census Bureau discontinued in June 2020, resumed in August and are ongoing.


The news — which relies largely on expert opinion, sensational anecdotes, and the performance of stocks — can give us a warped perspective of the real economy. This is true in general, and the problem is particularly acute right now. Amid all this noise, it is wise to periodically turn to authoritative sources of data to get a better sense of what is actually happening. To that end, here are several useful references that provide near real-time snapshots into various aspects of the real economy:


  • U.S. Census Bureau Small Business Pulse Surveys — The Census Bureau, known primarily for its once-a-decade census, has a broader mandate to produce data about the American people and economy. In response to the current health crisis, the organization has done a good job of tracking small business sentiment on a weekly basis, providing a good (and moderately reassuring) sense for the state of American small businesses, which are generally defined as manufacturing companies with 500 employees or fewer or non-manufacturing businesses with $7.5 million in revenue. This survey has been discontinued as of the end of June but is likely to resume in August.


  • Foot Traffic — This series of charts from SafeGraph shows the impact of the pandemic on foot traffic in the U.S. and provides great perspective on how different fascets of the economy — regions, industries, brands, and even restaurant categories — are recovering. Home Depot, for instance, has witnessed a rise in customer foot traffic since the beginning of the pandemic, whereas traffic at Starbucks is still over 20% off pre-pandemic levels.


  • Bloomberg Global Indicators — This dashboard shows 12 regularly updated key economic indicators from around the world. These include PMI (this is an index based on monthly surveys of private sector companies), U.S. employment, and U.S. consumer spending — all of which have an enormous impact on the current state of the economy and its near-term future.


  • Department of Transportation Transportation Services Index — This index provides trends in passenger and freight transportation and shows that the pandemic has had a relatively minor impact on freight (down 8% from January) relative to passenger transportation (down 93%). The DOT also publishes a Week in Transportation, which provides updated information on the number of people staying home, the number of commercial flights, and the volume of NYC subway ridership.


  • Mergers & Acquisitions — As a business owner, you may be wondering about the current state of M&A transactions. These fell down precipitously (36%) for the first half of 2020 in the U.S. but are witnessing a rise, as captured by a mid-year update by Bain & Company. The report notes that "Market volatility and hard questions about how much consumer behavior has changed in various industries make it difficult to develop conviction around valuations." Still, there's an ample amount of dry powder out there. BizBuySell also has a useful report on the state of deal activity, which shows similar trends for the smallest of businesses.


  • Global Trade Update — Finally, Knoema does an excellent job of capturing the state of world trade through its tremendous aggregation of datasets. This provides a long-term view and is not as current as some of the other data, but it provides important context for the U.S. economy, which is the world's largest importer and second largest exporter.

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